The Austrian School, also known as the “Vienna School” or the “Psychological School,” is a school of economic thought that advocates adherence to strict methodological individualism. As a result Austrians hold that the only valid economic theory is logically derived from basic principles of human action. Alongside the formal approach to theory, often called praxeology, the school has traditionally advocated an interpretive approach to history. The praxeological method allows for the discovery of economic laws valid for all human action, while the interpretive approach addresses specific historical events.

The core of the Austrian framework can be summarized as taking a "subjectivist approach to marginal economics," and a focus on the idea that logical consistency of a theory is more important that any interpretation of empirical observations. Their idea that value derives from utility, not from the labor invested in its production, contradicted Karl Marx's labor theory of value that ignored the ability of an item to satisfy human wants as a measure of its value.

History

The story of the Austrian School begins in the fifteenth century, when the followers of St. Thomas Aquinas, writing and teaching at the University of Salamanca in Spain, sought to explain the full range of human action and social organization. These Late Scholastics observed the existence of economic law, inexorable forces of cause and effect that operate very much as other natural laws. Over the course of several generations, they discovered and explained the laws of supply and demand, the cause of inflation, the operation of foreign exchange rates, and the subjective nature of economic value—all reasons Joseph Schumpeter celebrated them as the first real economists.

The Late Scholastics were advocates of property rights and the freedom to contract and trade. They celebrated the contribution of business to society, while doggedly opposing taxes, price controls, and regulations that inhibited enterprise. As moral theologians, they urged governments to obey ethical strictures against theft and murder. And they lived up to Ludwig von Mises's rule: the first job of an economist is to tell governments what they cannot do.

Austrian School Proper

The Austrian school owes its name to members of the GermanHistorical School of economics, who argued against the Austrians during the Methodenstreit, in which the Austrians defended the reliance that classical economists placed upon deductive logic. Their Prussian opponents derisively named them the “Austrian School” to emphasize a departure from mainstream German thought and to suggest a provincial, Aristotelian approach. (The name “Psychological School” derived from the effort to found marginalism upon prior considerations, largely psychological.)

By way of general fascination over Principles of Economics (1871), Carl Menger (1840-1921) then became the founder of the Austrian School proper, resurrected the Scholastic-French approach to economics, and put it on firmer ground. In addition, Menger showed how money originates in a free market when the most marketable commodity is desired, not for consumption, but for use in trading for other goods.

Menger's book was a pillar of the "marginalist revolution" in the history of economic science. When Ludwig von Mises said it "made an economist" out of him, he was not only referring to Menger's theory of money and prices, but also his approach to the discipline itself. Like his predecessors in the tradition, Menger was a classical liberal and methodological individualist, viewing economics as the science of individual choice. His Investigations, which came out twelve years later, battled the German Historical School, which rejected theory and saw economics as the accumulation of data in service of the state.

As professor of economics at the University of Vienna, Menger restored economics as the science of human action based on deductive logic, and prepared the way for later theorists to counter the influence of socialist thought. Indeed, his student Friedrich von Wieser (1851-1926) strongly influenced Friedrich von Hayek's later writings. Menger's work remains an excellent introduction to the economic way of thinking. At some level, every Austrian since has seen himself as a student of Menger.

The next great contributions of the Austrian School were made soon. Friedrich von Wieser (1889) detailed and expanded Menger's theory of imputation in production and alternative cost, while Eugen von Boehm-Bawerk (1889) developed his own distinctive time-dependent theory of capital and interest.

Boehm-Bawerk's Positive Theory of Capital demonstrated that the normal rate of business profit is the interest rate. Capitalists save money, pay laborers, and wait until the final product is sold to receive profit. In addition, he demonstrated that capital is not homogeneous but an intricate and diverse structure that has a time dimension. A growing economy is not just a consequence of increased capital investment, but also of longer and longer processes of production. His History and Critique of Interest Theories, appearing in 1884, is a sweeping account of fallacies in the history of thought and a firm defense of the idea that the interest rate is not an artificial construct but an inherent part of the market. It reflects the universal fact of "time preference," the tendency of people to prefer satisfaction of wants sooner rather than later.

The "First" Generation of the Austrian School was thus composed of a pair Austrian professors who, although not directly students of Menger, were nonetheless heavily influenced by him: Friedrich von Wieser and Eugen von Böhm-Bawerk. Boehm-Bawerk and von Wieser, for the most part, spread the Austrian School gospel throughout the Austro-Hungarian Empire and trained the next two generations. These later generations were dominated by the figures of Ludwig von Mises (1881-1973) in the second generation of “Austrian School of Economics” and, in the third generation, by Friedrich von Hayek (1889-1992).

One area where Boehm-Bawerk had not elaborated on the analysis of Menger was money, the institutional intersection of the "micro" and "macro" approach. This time, young Mises, economic adviser to the Austrian Chamber of Commerce, took on the challenge. The result of Mises's research was The Theory of Money and Credit, published in 1912. He spelled out how the theory of marginal utility applies to money, and laid out his "regression theorem," showing that money not only originates in the market, but must always do so. Drawing on the British Currency School, Knut Wicksell's theory of interest rates, and Boehm-Bawerk's theory of the structure of production, Mises presented the broad outline of the Austrian theory of the business cycle.

Major features

There are a number of features that distinguish the Austrian school from other approaches to economics. While not all "Austrians" subscribe to all of them, generally the school is characterized by these beliefs.

Austrian economists do not use mathematics in their analyses or theories because they do not think mathematics can capture the complex reality of human action. They believe that as people act, change occurs, and that quantifiable relationships are applicable only when there is no change. Mathematics can capture what has taken place, but can never capture what will take place.

Austrians focus completely on the opportunity cost goods, as opposed to balancing downside or disutility costs. It is an Austrian assertion that everyone is better off in a mutually voluntary exchange, or they would not have carried it out.

Methodological subjectivism

A radically "subjectivist" strain of Neoclassical economics, also called "marginalist," (versus Classical School), the Austrian school assumes that an individual's actions and choices are based upon a unique value scale known only to that individual. It is this subjective valuation of goods that creates economic value. Like other economists, the Austrian does not judge or criticize these subjective values but instead takes them as given data. But unlike other economists, the Austrian never attempts to measure or put these values in mathematical form. The idea that an individual's values, plans, expectations, and understanding of reality are all subjective permeates the Austrian tradition and, along with an emphasis on change or processes, is the basis for their notion of economic efficiency.

Methodological individualism

Economics, to an Austrian economist, is the study of purposeful human action in its broadest sense. Since only individuals act, the focus of study for the Austrian economist is always on the individual. Although Austrian economists are not alone in their methodological individualism, they do not stress the maximizing behavior of individuals in the same way as mainstream neoclassical economists.

Austrian economists believe that one can never know if humans have maximized benefits or minimized costs. Austrian economists emphasize instead the process by which market participants gain information and form their expectations in order to lead them to their own idea of a best solution.

After the 1871 presentation of his revolutionary subjective theory of value, Carl Menger was challenged by Gustav Schmoller and the recurrent debate on method or methodenstreit which ensued between them and their followers divided the German-speaking world neatly: Austria and its universities for the Austrian School; Germany and its universities for the German Historical School.

Disorganized competitive market processes

According to the Austrian approach, the demand for one's market product will depend on how many, if any, new competitors will enter that market. Offering a product on the market is always a trial-and-error, never-ending process of changing one's plans to reflect new knowledge one gains from day to day.

They stress the importance of competitive markets and a price system in organizing a decentralized morass of economic agents with limited knowledge into a harmonious order (going directly against the views of Marxian and Keynesian economists).

An individual's action takes place through time. A person decides on a desired end, chooses a means to attain that end, and then acts to attain it. But because all individuals act under the condition of uncertainty—especially uncertainty regarding the plans and actions of other individuals—people sometimes do not achieve their desired ends. The actions of one person may interfere with the actions of another. The actual consequences of any action can be known only after the action has taken place. This does not mean that people do not include in their plans expectations regarding the plans of others. But the exact outcome of a vast number of plans being executed at the same time can never be predicted. When offering a product on the market, for example, a producer can only guess as to what price can be asked.

The most important economic problem that people face, according to Austrian economists, is how to coordinate their plans with those of other people. Why, for example, when a person goes to a store to buy an apple, is the apple there to be bought? This meshing of individual plans in a world of uncertainty is, to Austrians, the basic economic problem. Austrians stress uncertainty in the making of economic decisions, rather than relying on "Homo economicus" or the rational man who was fully informed of all circumstances impinging on his decisions. The fact that perfect knowledge never exists, means that all economic activity implies risk.

Antitrust behavior

Their theory of "alternative cost" reduces all goods and factors, by "imputation," to the subjective valuation of consumer goods (versus Classical School and Marshallian Neoclassicals). The neoclassical economic theory of perfect competition defines a competitive market as one in which there are a large number of small firms, all selling a homogeneous good and possessing perfect knowledge.

The structure of the market, according to this analysis, determines the competitiveness of a market. But Austrian economists Friedrich A. Hayek and Israel M. Kirzner have rejected this theory of competition. According to Hayek there is no competition in the neoclassical theory of "perfect" competition. Competition to an Austrian economist is defined simply as rivalrous behavior, and to compete is to attempt to offer a better deal than one's competitors.

Competition in the market arises out of one firm distinguishing its products in some way from those of other firms. And because firms in the real world do not have perfect knowledge, they do not know what a successful competitive strategy is until they try it. "Competition is," therefore, as Hayek explains, a "discovery procedure." As each firm attempts to do better than all other firms, the knowledge of what consumers actually want in the market is discovered.

Monetary over-investment theory of the business cycle

This focus on opportunity cost alone means that their interpretation of the time value of a good has a strict relationship: since goods will be as restricted by scarcity at a later point in time as they are now, the strict relationship between investment and time must also hold.

A factory making goods next year is worth as much less as the goods it is making next year are worth. This means that the business cycle is driven by mis-coordination between sectors of the same economy, caused by money not carrying incentive information correct about present choices, rather than within a single economy where money causes people to make bad decisions about how to spend their time. This leads to monetary overinvestment theory of the business cycle (versus Keynesians).

Hayek and Mises authored many studies on the business cycle, warning of the danger of credit expansion, and predicted the coming currency crisis. This work was cited by the Nobel Prize committee in 1974 when Hayek received the award for economics. Working in England and America, Hayek later became a prime opponent of Keynesian economics with books on exchange rates, capital theory, and monetary reform.

Hayek's popular book Road to Serfdom (1944) helped revive the classical liberal movement in America after the New Deal and World War II. His series Law, Legislation, and Liberty elaborated on the Late Scholastic approach to law, applying it to criticize egalitarianism and nostrums like social justice.

Mises' New York seminar continued until two years before his death in 1973. During those years, Murray Rothbard was his student. Indeed, Rothbard's Man, Economy, and State (1963) was patterned after Human Action (Mises 1949), and in some areas—monopoly theory, utility and welfare, and the theory of the state—tightened and strengthened Mises' own views.

Rothbard's approach to the Austrian School followed directly in the line of Late Scholastic thought by applying economic science within a framework of a natural-rights theory of property. What resulted was a full-fledged defense of a capitalistic and stateless social order, based on property and freedom of association and contract.

Criticism

The Austrian school is generally criticized for its rejection of the scientific method and empirical testing in favor of supposedly self-evident axioms and logical reasoning. Bryan Caplan has criticized the school for rejecting on principle the use of mathematics or econometrics which is "more than anything else, what prevents Austrian economists from getting more publications in mainstream journals."

Note that the economists aligned with the Austrian School are sometimes colloquially called "the Austrians" even though not all held Austrian citizenship, and not all economists from Austria subscribe to the ideas of the Austrian School.

Credits

New World Encyclopedia writers and editors rewrote and completed the Wikipedia article in accordance with New World Encyclopediastandards. This article abides by terms of the Creative Commons CC-by-sa 3.0 License (CC-by-sa), which may be used and disseminated with proper attribution. Credit is due under the terms of this license that can reference both the New World Encyclopedia contributors and the selfless volunteer contributors of the Wikimedia Foundation. To cite this article click here for a list of acceptable citing formats.The history of earlier contributions by wikipedians is accessible to researchers here: